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  • 10-Q (Aug 9, 2011)

 
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Conceptus 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-10.2
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission File Number: 0-27596

 

 

CONCEPTUS, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   94-3170244

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

331 East Evelyn

Mountain View, CA 94041

(Address of Principal Executive Offices) (Zip Code)

(650) 962-4000

(Registrant’s Telephone Number, Including Area Code)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of Exchange Act).    Yes  ¨    No  x

There were 31,240,342 shares of Registrant’s Common Stock issued and outstanding as of November 1, 2011.

 

 

 


Table of Contents

CONCEPTUS, INC.

Form 10-Q for the Quarter Ended September 30, 2011

 

         Page  

Part I.

  Financial Information   

Item 1.

  Condensed Consolidated Financial Statements (Unaudited)   
 

a) Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010

     3   
 

b) Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010

     4   
 

c) Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010

     5   
 

d) Notes to Condensed Consolidated Financial Statements

     6   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      20   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      30   

Item 4.

  Controls and Procedures      31   

Part II.

  Other Information   

Item 1.

  Legal Proceedings      32   

Item 1A.

  Risk Factors      33   

Item 6.

  Exhibits      35   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

Item  1. Condensed Consolidated Financial Statements.

Conceptus, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands)

 

     September 30,
2011
    December 31,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 24,537      $ 18,383   

Short-term investments

     60,508        59,398   

Accounts receivable, net

     18,900        20,451   

Inventories

     3,817        2,915   

Short-term deferred tax assets

     5,061        5,058   

Other current assets

     6,296        7,003   
  

 

 

   

 

 

 

Total current assets

     119,119        113,208   

Property and equipment, net

     9,948        10,062   

Intangible assets, net

     21,791        24,145   

Long-term investments

     14,734        13,104   

Restricted cash

     130        367   

Goodwill

     16,428        16,013   

Long-term deferred tax assets

     74,009        73,696   

Other assets

     215        151   
  

 

 

   

 

 

 

Total assets

   $ 256,374      $ 250,746   
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 5,817      $ 5,921   

Accrued compensation

     6,927        6,170   

Notes payable

     84,449        80,960   

Other accrued liabilities

     4,827        3,736   
  

 

 

   

 

 

 

Total current liabilities

     102,020        96,787   

Deferred tax liabilities

     904        1,007   

Other accrued liabilities

     1,308        1,366   
  

 

 

   

 

 

 

Total liabilities

     104,232        99,160   
  

 

 

   

 

 

 

Contingencies (Note 15)

    

Stockholders’ equity:

    

Common stock and additional paid-in capital:

    

$0.003 par value, 53,000,000 shares authorized, 31,318,205 and 31,201,645 shares issued and 31,240,342 and 31,123,782 shares outstanding at at September 30, 2011 and December 31, 2010

     311,955        306,276   

Accumulated other comprehensive loss

     (2,089     (2,341

Accumulated deficit

     (157,724     (152,349

Treasury stock, 77,863 shares, at cost

     —          —     
  

 

 

   

 

 

 

Total stockholders’ equity

     152,142        151,586   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity.

   $ 256,374      $ 250,746   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

Conceptus, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share amounts)

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     2011     2010     2011     2010  

Net sales

   $ 33,093      $ 33,882      $ 93,468      $ 104,087   

Cost of goods sold

     5,748        6,562        17,063        20,238   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     27,345        27,320        76,405        83,849   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Research and development

     2,144        1,610        5,574        5,171   

Selling, general and administrative

     23,723        22,968        71,122        75,277   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     25,867        24,578        76,696        80,448   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     1,478        2,742        (291     3,401   

Interest income

     163        165        514        637   

Interest expense

     (1,787     (1,725     (5,295     (5,251

Other income, net

     (36     (1     (52     9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and other income (expense), net

     (1,660     (1,561     (4,833     (4,605
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for income taxes

     (182     1,181        (5,124     (1,204

Provision for income taxes

     2,720        205        251        461   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (2,902   $ 976      $ (5,375   $ (1,665
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic income (loss) per share:

        

Net income (loss)

   $ (0.09   $ 0.03      $ (0.17   $ (0.05

Shares used in per share amounts

     31,239        31,072        31,177        31,012   

Diluted income (loss) per share:

        

Net income (loss)

   $ (0.09   $ 0.03      $ (0.17   $ (0.05

Shares used in per share amounts

     31,239        31,413        31,177        31,012   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

Conceptus, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

     Nine months ended
September 30,
 
     2011     2010  

Cash flows from operating activities

    

Net loss

   $ (5,375   $ (1,665

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization of property plant and equipment

     3,965        3,418   

Amortization of debt issuance costs

     351        349   

Accretion of notes payable

     3,489        3,298   

Amortization of intangibles

     2,448        2,437   

Amortization and accretion of discount and premium on investments

     1,323        714   

Loss on put option

     —          2,933   

Gain on trading securities

     —          (2,949

Stock-based compensation expense

     5,233        5,412   

Loss on disposal of property and equipment

     182        18   

Changes in operating assets and liabilities:

    

Accounts receivable, net

     1,698        (2,046

Inventories

     (856     703   

Prepaids and other assets

     828        (987

Deferred tax asset

     (313     —     

Accounts payable

     (210     413   

Accrued compensation

     694        (2,331

Deferred tax liabilities

     (135     —     

Other accrued and long term liabilities

     1,118        235   
  

 

 

   

 

 

 

Net cash provided by operating activities

     14,440        9,952   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Sales and maturities of investments

     80,494        68,644   

Purchase of investments

     (85,290     (89,848

Restricted cash

     237        (6

Purchase of property and equipment

     (4,344     (4,136
  

 

 

   

 

 

 

Net cash used in investing activities

     (8,903     (25,346
  

 

 

   

 

 

 

Cash flows from financing activities

    

Proceeds from line of credit

     —          6,615   

Repayment of line of credit

     —          (35,855

Proceeds from stock options and awards exercises

     447        2,318   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     447        (26,922
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     170        (77

Net increase (decrease) in cash and cash equivalents

     6,154        (42,393

Cash and cash equivalents at beginning of the period

     18,383        61,658   
  

 

 

   

 

 

 

Cash and cash equivalents at end of the period

   $ 24,537      $ 19,265   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5


Table of Contents

Conceptus, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the instructions to Form 10-Q and Article 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair statement have been included.

The condensed consolidated balance sheet as of December 31, 2010 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. This financial data should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for the three and nine months ended September 30, 2011 may not necessarily be indicative of the operating results for the full 2011 fiscal year or any other future interim periods.

We develop, manufacture and market the Essure® permanent birth control system, an innovative and proprietary medical device for women. The Essure system delivers a soft and flexible insert into a woman’s fallopian tubes, causing a benign tissue in-growth which blocks the fallopian tubes. Successfully placed Essure micro-inserts and the subsequent tissue growth around and through the micro-inserts prohibits the egg from traveling through the fallopian tube, preventing conception. The effectiveness rate of the Essure procedure determined in our clinical study is 99.8% after four years of follow-up. We obtained approval to market Essure in the European Union in February 2001 and obtained the U.S. Food and Drug Administration, or FDA, approval for Essure in November 2002. Approximately 570,000 women worldwide have undergone the Essure procedure and we sell the Essure system in over 30 countries worldwide.

In February 2007, we issued an aggregate principal amount of $86,250,000 of our 2.25% convertible senior notes due in 2027. If the notes are converted, then upon conversion, holders will receive cash and, in certain circumstances, shares of our common stock based on an initial conversion rate, subject to adjustment, of 35.8616 shares per $1,000 principal amount of notes (which represents an initial conversion price of $27.89 per share). Upon conversion, a holder would receive cash up to the principal amount of the note and our common stock in respect of such note’s conversion value in excess of such principal amount (“net shares settlement”). This net share settlement feature of the notes would reduce our liquidity, and we may not have sufficient funds to pay in full the cash obligation upon such conversion. The convertible senior notes are classified as current liabilities at September 30, 2011 and December 31, 2010 as the notes are convertible at the option of the holder during the period beginning December 15, 2011 and ending February 15, 2012. See Note 9 – Convertible Senior Notes. If the holders of the notes exercise this repurchase right, or “put”, we may need to raise additional funds through bank facilities, debt or equity offerings or other sources of capital in order to repurchase the notes. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve covenants that restrict us. Additional funding may not be available when needed or on terms acceptable to us. If we are unable to obtain additional capital, we may be required to delay, reduce the scope of or eliminate our research and development programs or reduce our sales and marketing activities.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04 – Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in Generally Accepted Accounting Principles (“GAAP”) and International Financing Reporting Standards (“IFRS”). ASU 2011-04 clarifies the application of existing fair value measurement requirements and results in common measurement and disclosure requirements in U.S. GAAP and IFRS. ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is to be applied prospectively for reporting periods beginning on or after December 15, 2011. We anticipate that the adoption of this standard will not materially impact our Condensed Consolidated Financial Statements.

 

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Table of Contents

In June 2011, the FASB issued ASU No. 2011-05 – Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in equity. ASU 2011-05 requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance is to be applied retrospectively for interim and annual periods beginning after December 15, 2011. On October 21, 2011, the FASB decided to propose a deferral of the new requirement to present reclassifications of other comprehensive income on the face of the income statement. Companies would still be required to adopt the other requirements contained in the new accounting standard for the presentation of comprehensive income. We anticipate that the adoption of this standard will not materially impact our Condensed Consolidated Financial Statements.

In September 2011, the FASB issued ASU No. 2011-08 – Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 gives entities the option to perform the two-step process only if they first perform a qualitative assessment to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount and conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. This new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. We anticipate adopting this guidance in our fourth quarter of fiscal 2012 at the time we perform our annual goodwill test and do not expect that this standard will materially impact our Condensed Consolidated Financial Statements.

 

2. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. The primary estimates underlying our financial statements include the allowance for doubtful accounts receivable, product warranty, the fair value of our investment portfolio, assumptions regarding variables used in calculating the fair value of our equity awards, impairment of goodwill, intangibles and other long-lived assets, income taxes and contingent liabilities. Actual results could differ from those estimates.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and our wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Functional Currency

On January 7, 2008, we acquired Conceptus SAS (“SAS”), which sells to customers throughout Europe. Sales by SAS are denominated in Euros. In December 2008, we incorporated Conceptus Medical Limited (“CML”) as our United Kingdom subsidiary. In preparing our consolidated financial statements, we are required to translate the financial statements of SAS and CML from the currency in which they keep their accounting records into U.S. Dollars. SAS and CML both maintain their accounting records in the functional currency which is also their local currency. The functional currency of SAS is the Euro and the functional currency of CML is the British Pound. The functional currency is determined based on management’s judgment and involves consideration of all relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts a majority of its transactions, including billing, financing, payroll and other expenditures would be considered the functional currency, but any dependency upon the parent and the nature of the subsidiary’s operations must also be considered. Since the functional currency of SAS and CML has been determined to be their local currency, any gain or loss associated with the translation of SAS’s and CML’s financial statements into U.S. Dollars is included as a component of stockholders’ equity, in accumulated other comprehensive loss. If in the future we determine that there has been a change in the functional currency of SAS or CML from its local currency to the U.S. Dollar, any translation gains or losses arising after the date of change would be included within our statement of operations.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price paid over the fair value of tangible and identifiable intangible net assets acquired in business combinations. We perform an assessment of our goodwill at the reporting unit level annually, or earlier if an event occurs or circumstances change that would reduce the fair value of the reporting unit below its carrying amount. As of September 30, 2011, no indicators of impairment were identified.

 

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Table of Contents

Other intangible assets include patents, customer relationships, and license agreements. The patents include the patents acquired in 2009 in connection with our purchase of intellectual property assets from Ovion Inc. (“Ovion”). They are amortized using the straight-line method over their respective estimated useful lives.

Impairment of Long-Lived Assets

We account for the impairment of long-lived assets in accordance with ASC 350 Goodwill and Other. We evaluate the carrying value of our long-lived assets, consisting primarily of our property and equipment, the patents acquired in connection with our purchase of the intellectual property assets from Ovion, and intangible assets acquired in connection with our acquisition of SAS, whenever certain events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable (see Note 5 – Goodwill and Intangible Assets). Such events or circumstances include a prolonged industry downturn, a significant decline in our market value or significant reductions in projected future cash flows.

Significant judgments and assumptions are required in the forecast of future operating results used in the preparation of the estimated future cash flows, including profit margins, long-term forecasts of the amounts and timing of overall market growth and our percentage of that market, groupings of assets, discount rates and terminal growth rates. In addition, significant estimates and assumptions are required in the determination of the fair value of our tangible long-lived assets, including replacement cost, economic obsolescence and the value that could be realized in orderly liquidation. Changes in these estimates could have a material adverse effect on the assessment of our long-lived assets, thereby requiring us to write down the assets.

 

3. Investments

As of September 30, 2011 we had short and long-term investments of $75.2 million recorded at fair value. Our investments consist of corporate bonds, commercial paper, U.S. government bonds, U.S. treasury bills and time deposits. We will sell certain or all investments as needed to meet the cash flow needs of our business. Our investments in corporate bonds, commercial paper, U.S. government bonds, U.S. treasury bills and time deposits are classified as available-for-sale securities in accordance with ASC 320 Investments – Debt and Equity Securities. Investments are classified as short-term or long-term based on the underlying investments maturity date.

The following table summarizes our amortized cost, unrealized gains and loss, and the fair value of our available-for-sales investments, as of September 30, 2011 (in thousands):

 

     Amortized
Cost
     Gross
Unrealized
Gain
     Gross
Unrealized
Loss
    Estimated
Fair Value
 

Investments:

          

Corporate bonds

   $ 41,468       $ 52       $ (319   $ 41,201   

Commercial paper

     13,996         —           —          13,996   

U.S. government bonds

     8,606         3         (4     8,605   

U.S. treasury bills

     7,990         7         —          7,997   

Time deposits

     3,517         —           (74     3,443   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 75,577       $ 62       $ (397   $ 75,242   
  

 

 

    

 

 

    

 

 

   

 

 

 

Reported as:

          

Short-term investments

   $ 60,580       $ 57       $ (129   $ 60,508   

Long-term investments

     14,997         5         (268     14,734   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 75,577       $ 62       $ (397   $ 75,242   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

The following table summarizes our amortized cost, unrealized gains and loss and the fair value of our available-for-sales investments as of December 31, 2010 (in thousands):

 

     Amortized
Cost
     Gross
Unrealized
Gain
     Gross
Unrealized
Loss
    Estimated
Fair Value
 

Investments:

          

Corporate bonds

   $ 38,642       $ 96       $ (39   $ 38,699   

U.S. treasury bills

     13,989         6         —          13,995   

Commercial paper

     11,989         —           —          11,989   

U.S. & International government bonds

     4,549         20         (1     4,568   

Time deposits

     3,273         —           (22     3,251   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 72,442       $ 122       $ (62   $ 72,502   
  

 

 

    

 

 

    

 

 

   

 

 

 

Reported as:

          

Short-term investments

   $ 59,366       $ 58       $ (26   $ 59,398   

Long-term investments

     13,076         64         (36     13,104   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 72,442       $ 122       $ (62   $ 72,502   
  

 

 

    

 

 

    

 

 

   

 

 

 

We had several investments that were in an unrealized loss position as of September 30, 2011. We have determined that (i) we do not have the intent to sell any of these investments and (ii) it is more likely than not that we will not be required to sell any of these investments before recovery of the entire amortized cost basis. We review our investments to identify and evaluate investments that have an indication of possible impairment. As of September 30, 2011, we anticipate that we will recover the entire carrying value of such investments and have determined that no other-than-temporary impairments associated with credit losses were required to be recognized during the three and nine months ended September 30, 2011.

As of September 30, 2011 weighted average days to maturity for our available for sales securities was 175 days, with the longest maturity date being September 2013.

The following table presents our available-for-sale investments that are in an unrealized loss position as of September 30, 2011 (in thousands):

 

     Less than 12 Months     12 Months or Greater     Total  
     Fair
Value
     Gross
Unrealized
Loss
    Fair
Value
     Gross
Unrealized
Loss
    Fair
Value
     Gross
Unrealized
Loss
 

Corporate bonds

   $ 26,430       $ (126   $ 9,623       $ (193   $ 36,053       $ (319

U.S. government bonds

     2,915         (3     1,998         (1     4,913         (4

Time deposits

     1,499         —          1,943         (74     3,442         (74
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 30,844       $ (129   $ 13,564       $ (268   $ 44,408       $ (397
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

4. Fair Value Measurements

As defined in ASC 820 Fair Value Measurement and Disclosure (“ASC 820”), fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

Level 1: Quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

 

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Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

Fair value of Assets

Our cash equivalents and certain investments are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with a reasonable level of price transparency. During the three and nine months ended for the presented periods, there were no reclassifications or transfers among levels in the fair value hierarchy. As of September 30, 2011, our Level 1 instruments were investments in corporate bonds, U.S. treasury bills, U.S. government bonds, time deposits and cash equivalent commercial paper and money market funds.

We hold available-for-sale short-term commercial paper with highly rated financial institutions. There is no active market for such commercial paper; it is traded directly from the issuer or on an over-the-counter market. As of September 30, 2011, the carrying amount of the available-for-sale commercial paper is a reasonable estimate of fair value and these investments have been classified within Level 2 of the fair value hierarchy.

Periodically, we enter into forward contracts to buy U.S. Dollars at fixed intervals in the retail market in an over-the-counter environment. As of September 30, 2011, we had foreign currency forward contracts to sell 2.1 million Euros in exchange for $3.0 million maturing in October 2011 through December 2011. As of September 30, 2011, these forward contracts are recorded at their fair value of approximately $0.1 million as other current assets. We also have outstanding short-term intercompany receivables of $3.5 million as of September 30, 2011. We expect the changes in the fair value of the intercompany receivables to be materially offset by the changes in the fair value of the forward contracts.

The purpose of these forward contracts is to minimize the risk associated with foreign exchange rate fluctuations. We have developed a foreign currency exchange policy to govern our forward contracts. These foreign currency contracts do not qualify as cash flow hedges and all changes in fair value are reported in earnings as part of other income and expenses. We have not entered into any other types of derivative financial instruments for trading or speculative purpose. Our foreign currency forward contracts valuation inputs are based on quoted prices and quoted pricing intervals from public data and do not involve management judgment. Accordingly, we have classified our outstanding foreign currency forward contracts within Level 2 of the fair value hierarchy and have recorded the fair value of the contracts in other current assets on our condensed consolidated balance sheet as of September 30, 2011.

Assets measured at fair value on a recurring basis at September 30, 2011 are as follows (in thousands):

 

            Fair Value Measurements at Reporting Data  
     September 30
2011
     Quoted Price in
Active Markets
for Identical
Instruments
Level 1
     Significant
Other
Observable
Inputs
Level 2
     Significant
Unobservable
Inputs
Level 3
 

Assets:

           

Cash equivalents:

           

Commercial paper

   $ 13,999       $ 13,999       $ —         $ —     

Money market funds

     130         130         —           —     

Available-for-sale investments:

           

Corporate bonds

     41,201         41,201         —           —     

Commercial paper

     13,996         —           13,996         —     

U.S. government bonds

     8,605         8,605         —           —     

U.S. treasury bills

     7,997         7,997         —           —     

Time deposits

     3,443         3,443         —           —     

Foreign currency forward contracts

     73         —           73         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 89,444       $ 75,375       $ 14,069       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Assets measured at fair value on a recurring basis at December 31, 2010 are as follows (in thousands):

 

            Fair Value Measurements at Reporting Data  
     December 31
2010
     Quoted Price in
Active Markets
for Identical
Instruments
Level 1
     Significant
Other
Observable
Inputs
Level 2
     Significant
Unobservable
Inputs
Level 3
 

Assets:

           

Cash equivalents:

           

U.S. government bonds

   $ 2,000       $ 2,000       $ —         $ —     

Commercial paper

     2,000         2,000         —           —     

Money market funds

     1,368         1,368         —           —     

Available-for-sale investments:

           

Corporate bonds

     38,699         38,699         —           —     

U.S. treasury bills

     13,995         13,995         —           —     

Commercial paper

     11,989         —           11,989         —     

U.S. & International government bonds

     4,568         4,568         —           —     

Time deposits

     3,251         3,251         —           —     

Foreign currency forward contracts

     182         —           182         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 78,052       $ 65,881       $ 12,171       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Fair value of Liabilities

The fair value of the convertible senior notes (see Note 9 – Convertible Senior Notes) was estimated using quoted market prices. Accordingly, we have classified our convertible senior notes within Level 1 of the fair value hierarchy and have recorded the carrying value of the convertible senior notes in current liabilities in our condensed consolidated balance sheet as of September 30, 2011 and December 31, 2010 because the holders have the ability to require us to repurchase the notes in whole or part at a repurchase price of 100% of par beginning December 15, 2011 and ending February 15, 2012.

The following table summarizes the principal outstanding and estimated fair values of our debt (in thousands):

 

     September 30, 2011      December 31, 2010  
     Carrying Value      Fair Value      Carrying Value      Fair Value  

Convertible senior notes

   $ 84,449       $ 85,457       $ 80,960       $ 85,086   

 

5. Goodwill and Intangible Assets

Goodwill is tested for impairment, at the reporting unit level on an annual basis or more frequently upon the occurrence of circumstances that indicate that goodwill might be impaired. As of September 30, 2011, no indicators of impairment were identified.

The change in the carrying amount of goodwill for the nine months ended September 30, 2011 is as follows (in thousands):

 

     Nine Months Ended
September 30,
2011
 

Goodwill, beginning of period

   $ 16,013   

Effect of currency translation

     415   
  

 

 

 

Goodwill, end of period

   $ 16,428   
  

 

 

 

 

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The following table provides additional information concerning intangible assets, which are being amortized over straight-line periods ranging from 3 to 9 years (in thousands):

 

     Weighted
average
remaining life
(years)
     September 30, 2011      December 31,
2010
 
        Gross
carrying
amount
     Accumulated
amortization
    Cumulative
effect of
currency
translation
    Net book
value
     Net book value  

Patent and Licenses

     7.0       $ 25,750       $ (6,672   $ —        $ 19,078       $ 21,125   

Customer relationships

     5.3         5,024         (1,979     (332     2,713         3,020   
     

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total intangibles

      $ 30,774       $ (8,651   $ (332   $ 21,791       $ 24,145   
     

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

 

6. Inventories

Inventories are stated at the lower of cost or market. Cost is based on actual costs computed on a first-in, first-out basis. The components of inventories consist of the following (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Raw materials

   $ 7       $ 5   

Work-in-progress

     1,310         795   

Finished goods

     2,500         2,115   
  

 

 

    

 

 

 

Total

   $ 3,817       $ 2,915   
  

 

 

    

 

 

 

 

7. Warranty

We offer warranties on our product and record a liability at the time of the sale for the estimated future costs associated with warranty claims, which is based upon our historical experience and our estimate of the level of future costs. Warranty costs are reflected in the statement of operations as a cost of goods sold. A reconciliation of the changes in warranty liability for the nine months ended September 30, 2011 and 2010 are as follows (in thousands):

 

     Nine months ended
September 30,
 
     2011     2010  

Balance at the beginning of the period

   $ 333      $ 277   

Accruals for warranties issued during the period

     156        523   

Settlements made in kind during the period

     (292     (473
  

 

 

   

 

 

 

Balance at the end of the period

   $ 197      $ 327   
  

 

 

   

 

 

 

 

8. Stock-Based Compensation

Net loss for the three and nine months ended September 30, 2011 included approximately $1.8 million and $5.2 million, respectively, of stock-based compensation expense. Net income for the three months ended September 30, 2010 and net loss for the nine months ended September 30, 2010 included approximately $1.9 million and $5.4 million, respectively, of stock-based compensation expense.

Stock-based compensation expense under ASC 718, Compensation – Stock Compensation (“ASC 718”) relating to employee stock options, employee stock purchase plan and stock appreciation rights, is approximately $1.3 million and $1.5 million for the three months ended September 30, 2011 and 2010, respectively, and approximately $3.9 million and $4.5 million for the nine months ended September 30, 2011 and 2010, respectively. In addition, stock-based compensation expense of approximately $0.5 million and $0.4 million for the three months ended September 30, 2011 and 2010, respectively, and approximately $1.3 million and $0.9 million for the nine months ended September 30, 2011 and 2010, respectively, relates to employee restricted stock units. Stock-based compensation expense is measured at grant date, based on the fair value of the award, and is recognized on a straight line basis as expense over the employee requisite service period, which is generally the vesting period. In addition we recorded stock-based compensation expense for awards to non-employees as described in the following paragraph.

 

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Stock-based compensation arrangements to non-employees are accounted for in accordance with ASC 505-50 Equity Based Payments to Non-Employees, which requires that these equity instruments are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to adjustment as the underlying equity instruments vest. Stock-based compensation expense relating to non-employees was approximately $9,000 and $8,000 for the three months ended September 30, 2011 and 2010, respectively, and $48,000 and $45,000 for the nine months ended September 30, 2011 and 2010, respectively.

For the three and nine months ended September 30, 2011 and 2010, we calculated the fair value of each stock appreciation right on the date of grant using the Black-Scholes model as prescribed by ASC 718. The assumptions used were as follows:

 

     Nine Months Ended
September 30,
 
     2011     2010  

Expected term (in years)

     4.50        4.15   

Average risk-free interest rate

     1.75     1.97

Average volatility factor

     53.4     51.4

Dividend yield

     —          —     

 

During the three months ended September 30, 2011 and September 30, 2010 we granted no stock appreciation rights or stock options.

Stock Options and Stock Appreciation Rights: During the three and nine months ended September 30, 2011, we granted stock appreciation rights for zero and 578,000 shares of common stock, respectively, with an estimated total grant date fair value of approximately $3.4 million and a grant date weighted-average per share fair value of $5.86 per share for the nine months ended September 30, 2011. During the three and nine months ended September 30, 2010, we granted stock appreciation rights for zero and 457,500 shares of common stock, respectively, with an estimated total grant date fair value of approximately $3.8 million and a grant date weighted-average fair value of $8.31 per share for the nine months ended September 30, 2010.

Restricted Stock Units: In connection with restricted stock units granted, we recorded stock-based compensation expense representing the fair market value of our common shares on the dates the awards were granted. Stock-based compensation expense is being recorded on a straight-line basis over the vesting periods of the underlying stock awards. During the three and nine months ended September 30, 2011, we granted 15,333 and 200,171 restricted stock units, respectively, with a grant-date fair value of approximately $0.2 million and $2.6 million, respectively, and a grant-date weighted-average per share fair value of $11.67 and $12.74, respectively. During the three and nine months ended September 30, 2010, we granted zero and 170,187 restricted stock units, respectively, with a grant-date fair value of approximately $3.0 million, and a grant-date weighted-average fair value of $17.84 per share for the nine months ended September 30, 2010.

 

9. Convertible Senior Notes

In February 2007, we issued an aggregate principal amount of $86.3 million of our 2.25% convertible senior notes due 2027. These notes bear interest at a rate of 2.25% per annum on the principal amount, payable semiannually in arrears on February 15 and August 15 of each year, beginning on August 15, 2007.

The notes will mature on February 15, 2027, unless earlier redeemed, repurchased or purchased by us or converted, and are convertible into cash and, if applicable, shares of our common stock based on an initial conversion rate, subject to adjustment, of 35.8616 shares per $1,000 principal amount of notes (which represents an initial conversion price of approximately $27.89 per share), in certain circumstances. Upon conversion, a holder would receive cash up to the principal amount of the note and our common stock in respect of such note’s conversion value in excess of such principal amount. The notes are convertible only in the following circumstances: (1) if the closing sale price of our common stock exceeds 120% of the conversion price during a period as defined in the indenture; (2) if the average trading price per $1,000 principal amount of the notes is less than or equal to 97% of the average conversion value of the notes during a period as defined in the indenture; (3) upon the occurrence of specified corporate transactions; (4) if we call the notes for redemption and (5) at any time on or after December 15, 2011 up to and including February 15, 2012 and anytime on or after February 15, 2025. Upon a change in control or termination of trading, holders of the notes may require us to repurchase all or a portion of their notes for cash at a repurchase price equal to 100% of the principal amount, plus any accrued and unpaid interest.

 

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On or after February 15, 2012 we may redeem the notes in whole or in part at a redemption price in cash equal to 100% of the principal amount of the notes we redeem, plus any accrued and unpaid interest. On each of February 15, 2012, February 15, 2017 and February 15, 2022 holders may require us to purchase all or a portion of their notes at a purchase price in cash equal to 100% of the principal amount of the notes to be purchased, plus any accrued and unpaid interest. The convertible senior notes are classified as current liabilities at September 30, 2011 and December 31, 2010 as the notes are convertible at the option of the holder during the period beginning December 15, 2011 and ending February 15, 2012.

We may not have sufficient funds to pay the interest, purchase price, repurchase price or principal return when conversion is triggered or a note becomes payable under the above terms.

We concluded that the embedded stock conversion option is not considered a derivative under ASC 815 Derivative and Hedging (“ASC 815”), because the embedded stock conversion option would be recorded in stockholders’ equity if it were a freestanding instrument.

In connection with the offering, we entered into convertible note hedge transactions with affiliates of the initial purchasers. These transactions are intended to reduce the potential dilution to our stockholders upon any future conversion of the notes. The call options, which cost an aggregate $19.4 million, were recorded as a reduction of additional paid-in capital. We also entered into warrant transactions concurrently with the offering, pursuant to which we sold warrants to purchase approximately 3.1 million shares of our common stock to the same counterparties that entered into the convertible note hedge transactions. The convertible note hedge and warrant transactions effectively increased the conversion price of the convertible notes to approximately $36.47 per share of our common stock. Proceeds received from the issuance of the warrants totaled approximately $10.7 million and were recorded as an addition to additional paid-in capital.

ASC 815 provides that contracts are initially classified as equity if (1) the contract requires physical settlement or net-share settlement, or (2) the contract gives the company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The settlement terms of our purchased call options and sold warrant contracts require net-share settlement. Based on the guidance in ASC 815, the purchased call option contracts were recorded as a reduction of equity and the warrants were recorded as an addition to equity as of the trade date. ASC 815 states that a reporting entity shall not consider contracts to be derivative instruments if the contract issued or held by the reporting entity is both indexed to its own stock and classified in stockholders’ equity in its statement of financial position. We concluded the purchased call option contracts and the warrant contracts should be accounted for in stockholders’ equity.

Adoption of ASC 470-20

ASC 470-20 Debt with Conversion and Other Options (“ASC 470-20”) clarifies the accounting for convertible debt instruments that may be settled in cash upon conversion, including partial cash settlement. ASC 470-20 specifies that an issuer of such instruments should separately account for the liability and equity components of the instruments in a manner that reflect the issuer’s non-convertible debt borrowing rate which interest costs are recognized in subsequent periods. ASC 470-20 became effective for fiscal years beginning after December 15, 2008, and retrospective application was required for all periods presented. We adopted ASC 470-20 in the first quarter of fiscal 2009.

The effect of the adoption of ASC 470-20 was to bifurcate the debt and equity components of our convertible notes. The note payable principal balance at the date of issuance of $86.3 million in February 2007 was bifurcated into the debt component of $65.1 million and the equity component of $21.2 million. The difference between the note payable principal balance of $86.3 million and the $65.1 million value of the debt component is being accreted to interest expense over a period of 5 years, which, due to the holders’ put right, is the expected term of our notes payable. We reclassified $0.8 million of debt issuance costs to additional paid in capital, attributable to the equity component of the debt. The debt component was recognized at the present value of its cash flows discounted using a 5.51% discount rate, our borrowing rate at the date of the issuance of the notes for a similar debt instrument without the conversion feature.

Interest expense associated with the notes consisted of the following (in thousands):

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2011      2010      2011      2010  

Contractual coupon rate of interest

   $ 489       $ 489       $ 1,455       $ 1,455   

Accretion of notes payable

     1,179         1,115         3,489         3,298   

Amortization of debt issuance costs

     116         116         349         349   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest expense - convertible senior notes

   $ 1,784       $ 1,720       $ 5,293       $ 5,102   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The carrying amounts of the notes are as follows (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Carrying amount at beginning of the period

   $ 80,960       $ 76,531   

Accretion of note payable

     3,489         4,429   
  

 

 

    

 

 

 

Carrying amount at end of the period

   $ 84,449       $ 80,960   
  

 

 

    

 

 

 

 

10. Line of Credit

On August 25, 2011, we entered into a credit agreement (the “Agreement”) with a financial institution that provides for a revolving line of credit of up to $50.0 million to be used for working capital and general corporate purposes. The maturity date for any borrowings under the Agreement is August 25, 2016.

Outstanding borrowings under the Agreement will bear interest at either (i) a fluctuating rate of LIBOR in effect from time to time for a one month period plus 2.75% per annum or (ii) a fixed rate of LIBOR in effect on the first day of the applicable period continuing for one or three months, as designated by us, plus 2.75% per annum. In addition, commitment fees are payable quarterly on the unused portion of the line of credit at rate of 0.50% per annum.

Amounts outstanding under the Agreement are secured by substantially all of our existing and future assets, including, but not limited to, intellectual property, accounts receivable, inventory and contract rights, and by a pledge of our capital stock, the capital stock of SAS and the capital stock of any future subsidiaries, in each case subject to certain exceptions as set forth in the Agreement and related security documents.

In addition, the Agreement requires that our existing and future subsidiaries unconditionally and fully guarantee our obligations under the Agreement. Any guarantee shall be secured by unconditional, continuing pledges and security interests in and to all of the assets and properties of the guarantor, subject to certain exceptions as set forth in the Agreement.

The Agreement contains customary covenants, including but not limited to, the following financial covenants:

 

   

Net Leverage Ratio (as defined in the Agreement) of less than 1.50 to 1.00;

 

   

Adjusted Quick Ratio (as defined in the Agreement) of greater than 1.00 to 1.00 through March 30, 2012, adjusted on a quarterly basis thereafter until June 30, 2013 by reference to the amount of debt then outstanding under our convertible notes;

 

   

Capital expenditures not to exceed $8.0 million per year through 2014 or $9.0 million per year in 2015 and thereafter; and

 

   

A pre-tax profitability (measured on a rolling basis for the period of four consecutive quarters then ended) of at least $1.00 beginning on September 30, 2011.

As of September 30, 2011 we were not in compliance with the pre-tax profitability covenant. We received a waiver from the financial institution with respect to this covenant for the third quarter of 2011. As a result, we will continue to have the ability to draw down under the credit facility subject to our compliance with the Agreement’s other covenants.

The Agreement also contains covenants that restrict us and our subsidiaries’ ability to, among other things, incur or assume certain debt, merge or consolidate, materially change the nature of its business, acquire or dispose of assets, make guaranties or grant liens on its assets, make certain loans, advances or investments, declare dividends or make distribution or enter into transactions with affiliates.

Amounts available under the Agreement are available for immediate drawdown, subject to certain financial covenants and other restrictions, including the absence of any material adverse change, as determined by the financial institution, in our financial condition or business, or our asset’s market value or any collateral required under the Agreement. We cannot assure you that we will be able to comply or obtain a waiver, if necessary, from the financial institution with respect to the pre-tax profitability covenant or any other covenant in the future, which could restrict our ability to draw down under the Agreement in the future. As of September 30, 2011 we have no outstanding borrowings under the Agreement.

 

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Table of Contents
11. Income Taxes

For the three and nine months ended September 30, 2011, we recorded approximately $2.7 million and $0.3 million, of income tax expense, respectively. For the three and nine months ended September 30, 2010, we recorded approximately $0.2 million and $0.5 million of income tax expense, respectively. Our effective tax rate was (5%) for the nine months ended September 30, 2011 and (38%) for the nine months ended September 30, 2010.

In the United States, there was a full valuation allowance against our deferred tax assets for the period ended September 30, 2010. We released the valuation allowance on our U.S. federal and certain states deferred tax assets on December 31, 2010. As a result of the valuation allowance release, our effective tax rate for the nine months ended September 30, 2011 also includes Federal tax impact of our U.S. operations. We evaluate the likelihood of the realization of our deferred tax assets on a quarterly basis, and reduce the carrying amount of these deferred tax assets by a valuation allowance to the extent we believe they will not more likely than not be realized. We consider many factors when assessing the likelihood of future realization of deferred tax assets, including our recent cumulative earnings by jurisdiction, expectations of future taxable income, the carryforward periods available to utilize tax attributes and other relevant factors. We believe that the U.S. Federal and State tax attributes that have been recognized will be more likely than not realized within their available carry forward periods.

As of September 30, 2011, our federal returns for the years ended 2008 through the current period and most state returns for the years ended 2007 through the current period are still open to examination. In addition, all of the net operating losses and research and development credit carryforwards that may be used in future years are still subject to inquiry given that the statute of limitation for these items would be from the year of the utilization. The tax returns for our French subsidiary for the years ended 2005 to 2007 were examined and closed by the French tax authorities in 2008. The tax returns for our French subsidiary for the years ended 2008 through the current period are open to examination.

The amount of unrecognized tax benefits at September 30, 2011 was approximately $3.3 million, of which, if ultimately recognized, approximately $2.9 million would decrease the effective tax rate in the period in which the benefit is recognized.

We do not expect our unrecognized tax benefits to change significantly over the next 12 months. In connection with the adoption of ASC 740 Income Taxes, we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.

 

12. Computation of Net Income (Loss) Per Share

Basic net income (loss) per share excludes any potential dilutive effects of stock options, unvested restricted shares and restricted stock units and common stock shares subject to repurchase. Diluted net income (loss) per share includes the impact of potentially dilutive securities. In net loss periods presented, basic and diluted net loss per share are both computed using the weighted average number of common shares outstanding because the inclusion of the above noted items would be anti-dilutive.

 

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The following table provides a reconciliation of weighted-average number of common shares outstanding to the weighted-average number common shares outstanding used in computing basic and diluted net income (loss) per common share (in thousands):

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2011     2010      2011     2010  

Numerator:

         

Income (loss) available to common stockholders

   $ (2,902   $ 976       $ (5,375   $ (1,665
  

 

 

   

 

 

    

 

 

   

 

 

 

Denominator:

         

Denominator for basic earning per share -

         

Weighted-average number common shares outstanding used in computing basic net income (loss) per common share

     31,239        31,072         31,177        31,012   
  

 

 

   

 

 

    

 

 

   

 

 

 

Effective of dilutive securities:

         

Options & stock appreciation rights

     —          318         —          —     

Stock awards

     —          23         —          —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average number common shares outstanding used in computing diluted net income (loss) per common share

     31,239        31,413         31,177        31,012   
  

 

 

   

 

 

    

 

 

   

 

 

 

The following outstanding options, potential employee stock purchase plan shares, warrants, stock appreciation rights, restricted stock units and shares were excluded from the computation of diluted net loss per share, as their effect would have been antidilutive (in thousands):

 

     At September 30,  
     2011      2010  

Outstanding options and stock appreciation rights

     5,429         5,157   

Restricted stock units

     380         255   

Warrants issued in connection with our convertible notes

     3,093         3,093   
  

 

 

    

 

 

 

Total

     8,902         8,505   
  

 

 

    

 

 

 

The effects of conversion of our convertible senior notes are not included in the calculation of basic net income (loss) per share because their effect is anti-dilutive. In addition, our convertible senior notes were excluded from the diluted net income (loss) per share calculation because the conversion price was greater than the average market price of our stock during the period.

 

13. Comprehensive Income (Loss)

Comprehensive income (loss) represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. Our comprehensive income (loss) consists of cumulative translation adjustments and unrealized gain or loss on available-for-sale securities. A summary of the comprehensive income (loss) for the periods indicated is as follows (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011     2010      2011     2010  

Net income (loss)

   $ (2,902   $ 976       $ (5,375   $ (1,665

Other comprehensive income (loss)

         

Foreign currency translation adjustment, net of tax

     (935     2,018         648        (775

Changes to unrealized gain (loss) on available-for-sale securities

     (386     225         (396     133   
  

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income (loss)

   $ (4,223   $ 3,219       $ (5,123   $ (2,307
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

The balance of each component of accumulated other comprehensive loss, net of taxes, as of December 31, 2010 and September 30, 2011 consist of the following (in thousands):

 

     Foreign Currency
Translation
    Unrealized Gains
(Loss) on Available-
For-Sale Securities
    Accumulated
Other
Comprehensive
Loss
 

Balance as of December 31, 2010

   $ (2,402   $ 61      $ (2,341

Net change during the nine month period

     648        (396     252   
  

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2011

   $ (1,754   $ (335   $ (2,089
  

 

 

   

 

 

   

 

 

 

 

14. Segment Information

We operate in one business segment, which encompasses all geographical regions. We use one measurement of profitability and do not segregate our business for internal reporting.

Net sales by geographic region, based on shipping location of our customer, are as follows (in thousands, except percentages):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Net sales (in thousands)

   $ 33,093      $ 33,882      $ 93,468      $ 104,087   

United States of America

     78     81     74     77

France

     13     10     16     13

Rest of Europe

     8     7     9     8

Other

     1     2     1     2

No customer accounted for more than 10% of total net sales for the three and nine months ended September 30, 2011 and 2010. One customer accounted for 11% of our total gross accounts receivable at September 30, 2011. No customer accounted for more than 10% of our total gross accounts receivable at December 31, 2010.

 

15. Contingencies

From time to time, we may have certain contingent liabilities that arise in the ordinary course of our business activities. We account for contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. At September 30, 2011 we had no material outstanding contingent liabilities.

 

16. Legal Proceedings

On May 22, 2009, we filed a lawsuit in the United States District Court, Northern District of California against Hologic, Inc. seeking declaratory judgment by the Court that Hologic’s planned importation, use, sale or offer to sell of its forthcoming Adiana Permanent Contraception system will infringe several U.S. patents owned by us including U.S. Patent Nos. 6,634,361, 6,709,667, 7,237,552, 7,428,904 and 7,506,650, and an injunction prohibiting Hologic from importing, using, selling or offering to sell its Adiana system in the United States. Upon FDA approval of the Adiana Permanent Contraception system, we filed an Amended Complaint in July 2009 seeking a judgment that Hologic’s importation, use, sale and/or offer to sell the system infringes the same patents mentioned above and requested an injunction against such activity. On August 13, 2009, we filed a motion for preliminary injunction, requesting the Court to enjoin the Adiana system in the United States pending final judgment in the action. On August 25, 2009, Hologic filed its answer and asserted counterclaims against us that we were violating the Lanham Act and the California Statutory Unfair Competition Law. On October 14, 2009, we answered with our own counterclaims asserting that Hologic was violating the Lanham Act and the California Statutory Unfair Competition Law through its selling practices. A hearing was held on the motion for preliminary injunction on November 4, 2009 and an order denying the motion was issued on November 6, 2009. Upon stipulation of the parties, on January 19, 2010, all claims relating to three of the five asserted patents were dismissed with prejudice. A claim construction hearing was held on March 10, 2010. The Claim Construction Order was issued on March 24, 2010 with all but one of five terms favorably construed to us. On April 21, 2010 the Court issued an order granting our Motion to Amend our Complaint to assert counterclaims against Hologic that Hologic had engaged in unfair competition against us and had violated the Lanham Act. On August 10, 2010, the parties reached agreement to settle all the unfair competition claims of both parties with prejudice. The terms of the agreement are confidential. The parties filed cross –motions for summary judgment on October 28, 2010, which were heard on December 9, 2010. On December 16, 2010, the Court issued an order denying Hologic’s motions for summary judgment of non-infringement and invalidity of claims 37 and 38 of the asserted patent, granting Hologic’s motion for summary judgment of non-infringement as to claim 8, granting our motion for summary judgment as to non-infringing substitutes and the hypothetical negotiation date, and denying our motion for summary judgment of infringement. A jury trial on the two remaining patent claims was held from October 3 through 13, 2011. The jury verdict was in our favor on all counts. The jury found that Hologic indirectly infringed both patent claims and found that both patent claims were valid. The jury awarded us lost profits of $18.8 million based upon Hologic’s sales of Adiana through June 2011. A hearing on our motions for a permanent injunction prohibiting Hologic from importing, using selling or offering to sell Adiana in the United States, for lost profits from June 2011 to the present, and for interest on lost profits is scheduled for December 22, 2011. On that same date, the Court will hear any motion for a new trial or for judgment as a matter of law to be filed by Hologic by November 15, 2011.

 

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On August 10, 2010, Hologic filed a lawsuit in the United States District Court for the District of Massachusetts alleging that two of the twelve U.S. patents marked on our packaging, instructions for use, and marketing materials for our Essure® product do not cover the Essure product. On October 12, 2010, we made a Motion to Transfer to the United States District Court, Northern District of California and a Motion to Dismiss the action. On December 13, 2010, the Court denied the Motion to Transfer without prejudice to reconsideration upon submission of additional information about likely witnesses. The court heard our argument for our Motion to Dismiss on May 9, 2011 but has not yet ruled on the Motion. After the argument, we filed a Motion to Stay the litigation until the later of a ruling on the Motion to Dismiss and the trial in the infringement action described above. The Court granted that motion in orders entered July 5 and July 7, 2011, and the case is currently stayed.

 

17. Subsequent Events

On October 3, 2011 (the “Closing Date”), we established a subsidiary in the Netherlands, Conceptus B.V. (“the BV”) and entered into an Asset Sale and Purchase Agreement (“the Asset Purchase Agreement”) with Sigma Medical B.V. (the “Seller”) to purchase all distribution rights of the Essure device in the Netherlands and certain assets of the Seller, including inventory, certain employees, licenses, contracts and intellectual property related to the Essure device (the “Acquisition”). Prior to the Acquisition, the Seller had the rights to sell, market and distribute the Essure device in the Netherlands. As a result of this transaction, the BV became our wholly owned subsidiary and its results of operations will be consolidated with our results of operations starting on October 3, 2011.

On the Closing Date, we consummated the Acquisition for approximately 2.6 million Euros in cash that will be made in three installments as follows:

 

   

2,125,000 Euros was paid on the Closing Date;

 

   

250,000 Euros will be paid to the Seller on the date that is six-months after the Closing Date; and

 

   

250,000 Euros will be paid on the date that is the first anniversary of the Closing Date.

We are entitled to offset any claim for damages for breaches of certain representations and warranties or Seller’s failure to perform its obligations under the Asset Purchase Agreement against the second and third installments of the purchase price. In addition, the purchase price may be adjusted downward by not more than 500,000 Euros if the average sales price of Essure devices declines below specified levels during 2012.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto. This discussion contains forward-looking statements, including references to 2011 net sales and gross margins, increased product adoption, product improvements, expanded sales force and other forecasted items that involve risks and uncertainties such as our limited operating and sales history; the uncertainty of market acceptance of our product; dependence on obtaining and maintaining reimbursement; effectiveness and safety of our product over the long-term; our ability to obtain and maintain the necessary governmental clearances or approvals to market our product; our ability to develop and maintain proprietary aspects of our technology; our ability to manage our expansion; our limited history of manufacturing our product; our dependence on single source suppliers, third party manufacturers and co-marketers; intense competition in the medical device industry and in the contraception market; the inherent risk of exposure to product liability claims and product recalls; litigation risks and other factors referenced in this Form 10-Q. Our actual results could differ materially from those expressed or implied in these forward-looking statements as a result of various factors, including those discussed in our Annual Report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission on March 15, 2011 and those included elsewhere in this Form 10-Q.

Overview

We are a leader in the design, development, marketing and promotion of innovative solutions in women’s healthcare. Our flagship product is the proprietary Essure® permanent birth control system, which is the most effective non-surgical permanent birth control system available. The Essure system delivers a soft and flexible insert into a woman’s fallopian tubes, causing a benign tissue in-growth which blocks the fallopian tubes. Successfully placed Essure micro-inserts and the subsequent tissue growth around and through the micro-inserts prohibits the egg from traveling through the fallopian tube, preventing conception. The effectiveness rate of the Essure procedure determined in our clinical study is 99.8% after four years of follow-up. We obtained approval to market Essure in the European Union in February 2001 and obtained the U.S. Food and Drug Administration, or FDA, approval for Essure in November 2002. Approximately 570,000 women worldwide have undergone the Essure procedure and we sell the Essure system in over 30 countries worldwide.

We sell Essure directly in France through our wholly owned subsidiary, Conceptus SAS (“SAS”), as well as indirectly through a network of distributors throughout the rest of Europe. Our newly acquired, wholly owned subsidiary in the Netherlands, Conceptus B.V., serves as our direct sales organization in the Netherlands. Our wholly owned subsidiary in the United Kingdom, Conceptus Medical Limited (“CML”), serves as our direct sales office in the United Kingdom.

In 2009 we received a positive review from the National Institute for Health and Clinical Excellence (“NICE”) in the United Kingdom and a regulatory approval for the Essure procedure from the Brazilian National Health Surveillance Agency (“ANVISA”).

During the first quarter of 2011 we began to promote GYNECARE THERMACHOICE® III Uterine Balloon Therapy System in U.S. OB/GYN physician offices. GYNECARE THERMACHOICE® III is a global endometrial ablation product that is used to treat excessive uterine bleeding (menorrhagia). This product is manufactured for and marketed by ETHICON™ Women’s Health & Urology, a division of Ethicon, Inc.

Net sales information based on segments and geographic regions is provided in Note 14 – Segment Information in the Notes to Condensed Consolidated Financial Statements.

We were incorporated in the state of Delaware on September 18, 1992. We maintain three websites located at www.conceptus.com, www.essuremd.com and www.essure.com. We make available free of charge on or through our www.conceptus.com website, our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file or furnish such material to the Securities and Exchange Commission (SEC).

The Essure® Procedure

The Essure micro-insert is designed to be placed into each fallopian tube during a single procedure using a hysteroscope, an instrument that allows visual examination of the cervix and uterine cavity, and our minimally invasive delivery system. The delivery system consists of a disposable plastic handle connected to our proprietary guidewire and catheter system. The micro-insert is constructed of a stainless steel inner coil, a dynamic outer coil made from a nickel titanium alloy called Nitinol, which is commonly used in many medical devices and permanent implants, and a layer of polyethylene terephthalate, or polyester fibers, wound between the inner coils. Using the hysteroscope for guidance, the delivery catheter is guided through the uterus and into the opening of the fallopian tube. Once the physician has properly positioned the delivery system in the fallopian tube, the physician releases the micro-insert. When released, the micro-insert automatically expands to the contours of the fallopian tube and anchors itself in place. Over a three-month time frame, the polyester fibers within the micro-insert elicit a localized, benign tissue in-growth that occludes, or blocks, the fallopian tubes, thereby preventing conception.

 

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Currently, local anesthesia is used as the predominant method of controlling discomfort during the Essure procedure. General anesthesia is not typically used unless required by hospital protocol, if requested by the patient, or based on the experience and comfort level of the physician. The Essure procedure can be performed in the comfort of a physician’s office in less than ten minutes (average hysteroscopic time) without hormones, cutting, burning or the risks associated with general anesthesia or tubal ligation. A patient is typically discharged approximately 45 minutes after the Essure procedure. No overnight hospital stay is required. Furthermore, the Essure procedure is effective without drugs or hormones. There is a three-month waiting period after the Essure procedure is completed during which the patient must continue to use her current form of birth control or an alternative form while tissue in-growth occurs. After three months, U.S. patients complete a confirmation test called a hysterosalpingogram, or HSG, which provides confirmation to both the doctor and the patient of both the placement of the inserts and the occlusion of the fallopian tubes. Outside of the United States, the confirmation test entails a standard flat plate pelvic X-ray conducted three months after completion of the procedure, with a subsequent HSG if device location on the initial radiographic image appears suspicious. In February 2011, we received CE (Conformité Européenne) Mark approval to use Transvaginal Ultrasound, or TVU, to confirm proper placement of Essure micro-inserts three months following the Essure procedure. TVU is an alternative confirmation test to the standard flat plate pelvic X-ray, and both tests will be included in the European Physicians’ Instruction for Use.

The Essure® Procedure Benefits

With 99.8% effectiveness based on four years of follow up, the Essure procedure is the most effective form of permanent contraception on the market based on a comparison of four-year clinical trial data. We developed the Essure procedure in response to the market need for a less invasive and more cost effective permanent birth control solution for women whose families are complete. The Essure procedure is typically performed in a physician office setting without general anesthesia and women typically can return to their daily activities within one day. Other permanent birth control procedures, such as tubal ligation or vasectomy, are done in a hospital setting, entail general anesthesia and require additional recovery time. These and other benefits of the Essure procedure compared to other traditional permanent birth control procedures are highlighted below.

Benefits for the patients:

 

   

Proven four-year effectiveness rate of 99.8%;

 

   

Procedures performed in the comfort of the doctor’s office in less than 10 minutes;

 

   

No risks associated with incisions, general anesthesia or radiofrequency energy (common in other permanent birth control procedures);

 

   

No hormones;

 

   

Short recovery time most women are discharged within 45 minutes and they return to normal activities within 24 hours;

 

   

Confirmation — a three month follow-up test provides visible confirmation for women with reassurance that they are protected against unplanned pregnancy; and

 

   

Convenience — no recurring management of contraception usage after the confirmation test, which is performed three months after the initial procedure.

Benefits to the physician and healthcare system:

 

   

More efficient and productive solution due to savings related to cost and time such as the elimination of overhead, indirect and procedural costs related to anesthesia and post-operative care and hospital stays associated with tubal ligations;

 

   

Ability to visually confirm proper placement of radiopaque micro-insert during the procedure;

 

   

Short procedure time and relative ease of performing the procedure;

 

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No risks associated with incisions, general anesthesia, thermal injuries, bowel injuries or dilutional hyponatremia, induced by hypotonic solutions such as glycine; and

 

   

Less resource-intensive environment — while Essure procedures may be performed in various settings including the physician office, hospital operating room and an ambulatory surgery center, the majority of Essure procedures take place in physicians’ offices.

Benefits to the payers:

 

   

Lower cost procedure due to reduced use of general or regional anesthesia and reduced number of post-operative hospital stays;

 

   

Elimination of costs — no operating room expenses because the procedure can be performed in the physician’s office;

 

   

Cost savings resulting from the potential reduction of unplanned pregnancies; and

 

   

Most effective form of permanent birth control available, based on four years of clinical studies.

Physician Penetration

We require physicians to be preceptored for between three and five cases by a certified trainer before being able to perform the procedure independently. We continue to see an increase in the number of physicians becoming trained or who are in the process of training to perform the Essure procedure. The level of sales for the Essure system is highly dependent on the number of physicians trained to perform the procedure. However, we understand that a strong base of trained physicians does not necessarily correlate to a proportional increase in revenue. Furthermore, there are no revenues associated with the training activities. We do not charge a fee for the activity and no commitment arises for the physician from the preceptorship.

We partnered with VirtaMed AG in 2009 to develop a highly-realistic simulator called EssureSim™ that provides virtual reality training of the hysteroscopic procedure that deploys Essure. The training helps refine physicians’ skills to enhance patient outcomes. In September 2010, we entered into a mutually exclusive agreement with VirtaMed AG for EssureSim™, which enables us to be the only company in the field of hysteroscopic permanent birth control with a photorealistic, high fidelity VirtaMed training simulator.

Reimbursement of the Essure® Procedure

Market acceptance of the Essure system depends in part upon the availability of reimbursement within prevailing healthcare payment systems. We believe that physician advocacy of our product will be required to continue to obtain reimbursement. In the United States, as of November 9, 2011, we have received positive coverage decisions for the Essure procedure from most private insurers and from all of the 51 Medicaid programs and favorable Medicaid office reimbursement (defined as $1,700 or more) in 33 states. We continue to receive positive responses relating to reimbursement, which we believe will help increase the adoption of the Essure device by doctors and patients. We intend to continue our effort to educate payers of the cost-effectiveness of our product and to establish further programs to help physicians to navigate reimbursement issues. As with all healthcare plans, coverage will vary and is dependent upon the individual’s specific benefit plan.

Effective January 1, 2011, national average payment for hysteroscopic sterilization per the Centers for Medicare and Medicaid Service’s (“CMS”) Medicare Physician Fee Schedule is $428 when performed in a hospital (facility) and $1,925 when performed in a physician’s office (non-facility). The Current Procedural Terminology (“CPT”) code for hysteroscopic sterilization is 58565. The 2011 Medicare national average payment for hospital outpatient reimbursement amounts for CPT 58565 is $3,126, which also includes the cost of the implant. In 2011, the Medicare national average payment for CPT 58565 in the ambulatory surgery center is $1,758 which also includes the cost of the implant.

Reimbursement systems vary significantly by country and sometimes by region, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government-managed healthcare systems that determine reimbursement for new devices and procedures. In most markets, there are private insurance systems as well as government-managed systems.

In Europe, we are developing a strategic plan to obtain or maintain reimbursement in a number of European countries. In France, we have obtained official reimbursement with recommendation from Haute Autorité de Santé for the Essure procedure. Until, October 2010, the Essure procedure was covered in France for all age-appropriate women, regardless of their medical status. The Economic Committee for Healthcare Devices in France ruled in November 2007 that the reimbursement for the Essure device would remain at the then current levels of 663 Euros, net of value added tax, for the next five years. However, the French authorities have begun to implement cost cutting measures that are effecting reimbursement for medical devices and procedures, and specifically have changed the reimbursement of hysteroscopic occlusion for women under the age of 40.

 

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Our Market

Birth control use in the United States is prevalent among a majority of women of reproductive age, defined as 15-44 years of age. The National Survey of Family Growth, or NSFG, is a periodic survey that provides statistics on reproductive health in the United States and is conducted by the Centers for Disease Control and Prevention, National Center for Health Statistics. In 2010 NSFG published its most recent study entitled Use of Contraception in the United States: 1982–2008, which includes new data for 2006-2008. According to the NSFG for 2006-2008, of the 61.9 million women of reproductive age in the United States, 38.2 million use some form of birth control and 9.3 million women who use temporary contraception do not intend to have more children.

The 2006-2008 NSFG estimated that 37% of U.S. women who use contraception rely on sterilization for birth control, including tubal ligation and vasectomy, making permanent birth control the most common method of contraception in the United States. Data published in 2010 estimated that approximately 643,000 tubal ligation procedures are performed each year in the United States, and the prevalence increases with age and number of children. According to the 2006-2008 NSFG, approximately 90% of women in the United States who have chosen female sterilization, which includes tubal ligation, have birthed two or more children. According to the same source, among the women in the United States who have chosen female sterilization, which includes tubal ligation, approximately 89% are between the ages of 30 and 44.

We consider Essure’s target market to be those women who choose female sterilization, as well as the 9.3 million women in the U.S. who use temporary contraception and are done having children.

The 2006-2008 NSFG estimated that approximately 24.1 million women in the United States use temporary methods of birth control, such as oral contraceptives, condoms, implants and injectables. Of the women using temporary birth control, 28% choose oral contraceptives and 16% choose the male condom. Included in the group using temporary birth control, according to the same source, are approximately 7.8 million women who have two or more children. It is our belief that by making these women aware of the benefits a minimally invasive procedure offers, they will consider Essure in their continuum of family planning and opt for permanent birth control rather than their current temporary method once they are done having children.

Worldwide, there is a larger market for permanent birth control. According to the United Nations World Contraceptive Use 2011, a report on birth control methods used by reproductive couples worldwide, 63% of women aged 15-49 years were using a form of contraception. The report indicated that female sterilization which includes tubal ligation and is the leading birth control method worldwide, was used by 19% of those women, followed by intrauterine devices, or IUDs, at 14%, and oral contraceptives at 9%.

Additional Products

During the first quarter of 2011, we began to promote GYNECARE THERMACHOICE® III Uterine Balloon Therapy System in OB/GYN physician offices in the United States.

Essure and GYNECARE THERMACHOICE® III are compatible technologies that we believe are well-suited for the OB/GYN physician in-office setting. We believe this strategic partnership will ultimately drive Essure sales because patients who have had an endometrial ablation procedure are strongly advised to avoid pregnancy; thus it becomes a medical and practical necessity for a woman to obtain permanent birth control before having a GEA procedure. To date, GYNECARE THERMACHOICE® III has been sold primarily in the hospital setting. We intend to leverage our U.S. sales channel to sell GYNECARE THERMACHOICE® III to OB/GYN physician offices, and ultimately increase physician utilization of the Essure procedure.

 

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Results of Operations - Three and Nine Months Ended September 30, 2011 and 2010

(in thousands, except percentages)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2011     2010     2011-2010     2011     2010     2011-2010  
     Amount     % (a)     Amount      % (a)     % Change     Amount     % (a)     Amount     % (a)     % Change  

Net sales

   $ 33,093        100   $ 33,882         100     -2   $ 93,468        100   $ 104,087        100     -10

Gross profit

     27,345        83     27,320         81     0     76,405        82     83,849        81     -9

Research and development expenses

     2,144        6     1,610         5     33     5,574        6     5,171        5     8

Selling, general and administrative expenses

     23,723        72     22,968         68     3     71,122        76     75,277        72     -6

Net income (loss)

     (2,902     -9     976         3     -397     (5,375     -6     (1,665     -2     -223

 

(a) Expressed as a percentage of total net sales.

Net Sales

Net sales were $33.1 million for the three months ended September 30, 2011 as compared to $33.9 million for the three months ended September 30, 2010, representing a decrease of approximately $0.8 million, or 2%. Net sales were $93.5 million for the nine months ended September 30, 2011 as compared to $104.1 million for the nine months ended September 30, 2010, representing a decrease of approximately $10.6 million, or 10%. The decrease is primarily the result of continued macroeconomic pressures that have contributed to patients delaying non-urgent procedures such as Essure in the United States. In addition, in early 2010 we conducted a short-term multiple-city consumer awareness campaign that positively impacted incremental domestic sales in the third quarter of 2010. In 2011, we did not launch a consumer awareness campaign until September 2011; therefore we did not experience the same incremental domestic sales benefit from a consumer awareness campaign in the third quarter of 2011 as compared to the third quarter of 2010.

International sales were $7.3 million for the three months ended September 30, 2011 as compared to $6.6 million for the three months ended September 30, 2010, representing an increase of approximately $0.7 million, or 11%. International sales comprised 22% and 19% of our total net sales in the three months ended September 30, 2011 and 2010, respectively. International sales were $24.0 million for the nine months ended September 30, 2011 as compared to $23.5 million for the nine months ended September 30, 2010, representing an increase of approximately $0.5 million, or 2%. International sales comprised 26% and 23% of our total net sales in the nine months ended September 30, 2011 and 2010, respectively. The change in international sales levels for the periods presented were primarily due to higher average selling price due to channel mix of more sales to direct countries and less sales to distributor countries and a favorable currency exchange, offset by lower unit volume.

Net sales by geographic region, based on shipping location of our customers, are as follows (in thousands, except percentages):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Net sales (in thousands)

   $ 33,093      $ 33,882      $ 93,468      $ 104,087   

United States of America

     78     81     74     77

France

     13     10     16     13

Rest of Europe

     8     7     9     8

Other

     1     2     1     2

No customer accounted for more than 10% of total net sales for the three and nine months ended September 30, 2011 and 2010. One customer accounted for 11% of our total gross accounts receivable at September 30, 2011. No customer accounted for more than 10% of our total gross accounts receivable at December 31, 2010.

We expect our net sales for 2011 to be in the range of approximately $132.0 million to $136.0 million, which would represent a decline of approximately (6%) to (3%) from net sales in 2010. We believe our net sales in 2011 and beyond may continue to be significantly influenced by macroeconomic and insurance trends, including continued high unemployment in the U.S. and increased employee health insurance cost sharing resulting in higher deductibles and copays. Other potential factors include the number of physicians entering and completing training, physician utilization rates of the Essure procedure, the extent of additional favorable insurance coverage and reimbursement decisions, our ability to promote the GYNECARE THERMACHOICE® III in U.S. physician offices and our success in achieving patient awareness objectives. As we have noted elsewhere in this report and risk factors from our Form 10-K, our revenue projections involve many risk factors, some of which are not entirely within our control.

 

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Gross Profit

Cost of goods sold for the three months ended September 30, 2011 was $5.7 million as compared to $6.6 million for the three months ended September 30, 2010, which represents a decrease of $0.9 million, or 12%. Cost of goods sold for the nine months ended September 30, 2011 was $17.1 million as compared to $20.2 million for the nine months ended September 30, 2010, which represents a decrease of $3.1 million, or 16%. The gross margin for the three months ended September 30, 2011 was 83%, which is higher than the gross margin of 81% for the three months ended September 30, 2010. The gross margin for the nine months ended September 30, 2011 was 82%, which is higher than the gross margin of 81% for the nine months ended September 30, 2010. The gross margin increase was primarily due to decrease in product material costs.

Our gross profit margin will vary as our geographic mix changes. Increases in sales of our devices through distributors in international markets will tend to reduce our overall gross profit margin.

Research and Development Expenses

Research and development expenses were $2.1 million and $1.6 million for the three months ended September 30, 2011 and 2010, respectively, which represents an increase of $0.5 million, or 33%. As a percentage of net sales, research and development expenses for the three months ended September 30, 2011 and 2010 represented 6% and 5%, respectively. The dollar increase was the result of approximately $0.3 million related to payroll, stock compensation and recruiting expenses due to the expansion of our research and development team, and approximately $0.2 million related to clinical research.

Research and development expenses were $5.6 million and $5.2 million for the nine months ended September 30, 2011 and 2010, respectively, which represents an increase of $0.4 million, or 8%. As a percentage of net sales, research and development expenses for the nine months ended September 30, 2011 and 2010 represented 6% and 5%, respectively. The dollar increase was the result of approximately $0.5 million related to payroll, stock compensation and recruiting expenses due to the expansion of our research and development team, approximately $0.1 million related to clinical trials, approximately $0.1 million related to consulting expense, and approximately $0.2 million related to clinical research, offset by an approximately $0.5 million decrease in expensed materials related to prototypes.

Research and development expenses, which include expenditures related to product development, clinical research and regulatory affairs, are substantially related to the ongoing development and associated regulatory approvals of our technology. Our goal is to continue our product enhancements over the coming years, which are intended to result in improved ease of use and clinical performance.

We expect research and development expenses for the fourth quarter of 2011 to be comparable to our current quarter.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended September 30, 2011 were $23.7 million as compared to $23.0 million for the three months ended September 30, 2010, which represents an increase of $0.7 million, or 3%. As a percentage of net sales, selling, general and administrative expenses for the three months ended September 30, 2011 and 2010 represented 72% and 68%, respectively.

The dollar increase was the result of the following: (i) increased payroll expense of approximately $1.5 million primarily due to the expansion of the U.S. field sales force and marketing team, (ii) an increase of approximately $0.5 million related to marketing and licensing activities, and (iii) an increase of approximately $0.4 million in travel expenses. These expenses were partially offset by an approximately $1.7 million decrease in legal fees, primarily due to the lower legal expenses related to our legal proceedings against Hologic.

Selling, general and administrative expenses for the nine months ended September 30, 2011 were $71.1 million as compared to $75.3 million for the nine months ended September 30, 2010, which represents a decrease of $4.2 million, or 6%. As a percentage of net sales, selling, general and administrative expenses for the nine months ended September 30, 2011 and 2010 represented 76% and 72%, respectively.

 

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The dollar decrease was the result of the following: (i) a decrease of approximately $9.4 million in expenditures primarily related to the suspension of the short-term multiple-city consumer awareness campaign that was launched in early 2010, which was not repeated in the second half of 2011, (ii) a decrease of approximately $2.5 million in legal fees, primarily due to lower legal expenses related to our legal proceedings with Hologic. These decreases were partially offset by (i) increased payroll expense of approximately $5.7 million primarily due to the expansion of the U.S. field sales force and marketing team, (ii) an increase of approximately $1.2 million related to travel, and (iii) an increase of approximately $0.8 million in tax consulting fees and depreciation expense.

We expect selling, general and administrative expenses to be greater in the fourth quarter of 2011 as compared to the current quarter due to higher selling and marketing spend as we continue to fund our new direct to consumer advertising campaign and continue to hire additional sales professionals to grow our expanded sales territories and increase utilization of the Essure procedures.

Operating Income (Loss)

Operating income for the three months ended September 30, 2011 was $1.5 million as compared to $2.7 million for the three months ended September 30, 2010, which represents a decrease of $1.2 million. Operating loss for the nine months ended September 30, 2011 was $0.3 million as compared to operating income of $3.4 million for the comparable period last year, which represents a decrease of $3.7 million. This decrease is primarily due to the lower sales, offset by lower cost of goods sold due to lower product material cost and lower operating expenses for the nine months ended September 30, 2011 as compared to the comparable period last year.

Total interest and other income (expense), net

Total interest and other income (expense), net was $1.7 million and $1.6 million for the three months ended September 30, 2011 and September 30, 2010, respectively representing an increase of $0.1 million. Total interest and other income (expense), net for the nine months ended September 30, 2011 and 2010 was a net expense of $4.8 million and $4.6 million, respectively, representing an increase of $0.2 million, or 5%. For both three and nine month periods the increases in total interest and other income (expense), net were primarily due to lower yields on invested cash.

Provision for income taxes

For the three and nine months ended September 30, 2011, we recorded approximately $2.7 million and $0.3 million, of income tax expense, respectively. For the three and nine months ended September 30, 2010, we recorded approximately $0.2 million and $0.5 million of income tax expense, respectively. Our effective tax rate was (5%) for the nine months ended September 30, 2011 and (38%) for the nine months ended September 30, 2010.

In the United States, there was a full valuation allowance against our deferred tax assets for the period ended September 30, 2010. We released the valuation allowance on our U.S. federal and certain states deferred tax assets on December 31, 2010. As a result of the valuation allowance release, our effective tax rate for the nine months ended September 30, 2011 also includes Federal tax impact of our U.S. operations. We evaluate the likelihood of the realization of our deferred tax assets on a quarterly basis, and reduce the carrying amount of these deferred tax assets by a valuation allowance to the extent we believe they will not more likely than not be realized. We consider many factors when assessing the likelihood of future realization of deferred tax assets, including our recent cumulative earnings by jurisdiction, expectations of future taxable income, the carryforward periods available to utilize tax attributes and other relevant factors. We believe that the U.S. Federal and State tax attributes that have been recognized will be more likely than not realized within their available carry forward periods.

As of September 30, 2011, our federal returns for the years ended 2008 through the current period and most state returns for the years ended 2007 through the current period are still open to examination. In addition, all of the net operating losses and research and development credit carryforwards that may be used in future years are still subject to inquiry given that the statute of limitation for these items would be from the year of the utilization. The tax returns for our French subsidiary for the years ended 2005 to 2007 were examined and closed by the French tax authorities in 2008. The tax returns for our French subsidiary for the years ended 2008 through the current period are open to examination.

The amount of unrecognized tax benefits at September 30, 2011 was approximately $3.3 million, of which, if ultimately recognized, approximately $2.9 million would decrease the effective tax rate in the period in which the benefit is recognized.

 

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We do not expect our unrecognized tax benefits to change significantly over the next 12 months. In connection with the adoption of ASC 740 Income Taxes, we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.

Liquidity and Capital Resources

We have experienced significant cumulative operating losses since inception and, as of September 30, 2011, had an accumulated deficit of $157.7 million. Although we were profitable in 2010, we experienced a net loss in the first nine months of 2011 and there is a risk that we may not return to profitability. We will continue to expend substantial resources in the selling and marketing of the Essure system worldwide. We will remain in an accumulated deficit position unless sufficient net sales can be generated to offset expenses.

During the nine months ended September 30, 2011, we had invested $85.3 million in corporate bonds, U.S. government bonds, commercial paper, U.S. treasury bills and time deposits. We will sell certain or all investments as needed to meet the cash flow needs of our business. Our investments in corporate bonds, U.S. government bonds, commercial paper, U.S. treasury bills, and time deposits are classified as available-for-sale securities in accordance with ASC 320 Investments – Debt and Equity Securities. Investments are classified as short-term or long-term based on the underlying investments maturity date. As of September 30, 2011 we had $60.5 million classified as short-term investments and $14.7 million classified as long-term investments. See Note 3 – Investments, in the Notes to Condensed Consolidated Financial Statements.

The successful achievement of our business objectives may require additional financing and therefore, we may in the future seek to raise additional funds through bank facilities, debt or equity offerings or other sources of capital. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. Additional funding may not be available when needed or on terms acceptable to us. If we are unable to obtain additional capital, we may be required to delay, reduce the scope of or eliminate our sales and marketing and research and development activities. Our future liquidity and capital requirements will depend upon many factors, including, among others:

 

   

resources devoted to establish sales, marketing and distribution capabilities;

 

   

the rate of product adoption by doctors and patients;

 

   

our ability to successfully promote GYNECARE THERMACHOICE® III to U.S. physician offices and increase utilization of the Essure procedure as an adjunct to the global endometrial ablation procedure;

 

   

our ability to defend our existing physician accounts against competitive trialing and potential reduced market share of the hysteroscopic sterilization market;

 

   

our ability to acquire or invest in other products, technologies and businesses;

 

   

the market price of our common stock as it affects the exercise of stock options and the conversion terms of our convertible debt;

 

   

the insurance payer community’s acceptance of and reimbursement for the Essure system; and

 

   

the effect on our business due to competition.

As of September 30, 2011, we had cash and cash equivalents of $24.5 million, compared to $18.4 million at December 31, 2010. The increase of approximately $6.1 million of cash and cash equivalents is primarily due to cash provided by operating activities, with an offset from cash used in investing activities to purchase and sell investments and purchase of hysteroscopy and training equipment. In addition we had short-term and long-term investments of $75.2 million as of September 30, 2011, compared to $72.5 million of short-term and long-term investments at December 31, 2010.

On August 25, 2011, we entered into a credit agreement with a financial institution that provides for a revolving line of credit of up to $50.0 million to be used for working capital and general corporate purposes. The maturity date for any borrowings under the credit agreement is August 25, 2016. As of September 30, 2011 we have no outstanding borrowings under the credit agreement. See Note 10 – Line of Credit, in the Notes to Condensed Consolidated Financial Statements.

 

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Our convertible senior notes are classified as current liabilities at September 30, 2011 and December 31, 2010 as the notes are convertible at the option of the holder during the period beginning December 15, 2011 and ending February 15, 2012.

We believe that we have sufficient resources to meet our cash requirements and current liabilities for the next twelve months. We may seek to refinance our existing debt prior to the February 15, 2012 repurchase date.

Sources and Uses of Cash

Our cash flows for the nine months ended September 30, 2011 and 2010 are summarized as follows:

 

     Nine months ended
September 30,
 
     2011     2010  

Net cash provided by operating activities

   $ 14,440      $ 9,952   

Net cash used in investing activities

     (8,903     (25,346

Net cash provided by (used in) financing activities

     447        (26,922

Effect of exchange rate changes on cash and cash equivalents

     170        (77
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ 6,154      $ (42,393
  

 

 

   

 

 

 

Operating Activities

Net cash provided by operating activities was $14.4 million for the nine months ended September 30, 2011, as compared to $10.0 million provided for the nine months ended September 30, 2010. Net cash provided by operating activities in the nine months ended September 30, 2011 was primarily related to:

 

   

Net loss of $5.4 million;

 

   

Non-cash related items of $17.0 million corresponding to the accretion of notes payable, stock-based compensation, depreciation and amortization of fixed assets, debt issuance costs, intangible amortization and amortization and accretion of discount and premium on investments;

 

   

Decrease in accounts receivable of $1.7 million as a result of increased cash collections;

 

   

Increase in inventories of $0.9 million;

 

   

Decrease in prepaid assets of $0.8 million primarily due to timing;

 

   

Increase in tax assets of $0.3 million and decrease in deferred tax liabilities of $0.1 primarily due to tax provision activity related to the year to date book loss which is expected to offset taxable income in future quarters;

 

   

Decrease in accounts payable of $0.2 million primarily related to timing of payments;

 

   

Increase in accrued compensation of $0.7 million primarily due to the accrual for incentive payments as compared to prior year; and

 

   

Increase in other accrued and long-term liabilities of $1.1 million due primarily to the increase in deferred revenue.

Net cash provided by operating activities for the nine months ended September 30, 2010 was primarily related to:

 

   

Net loss of $1.7 million;

 

   

A $15.6 million increase corresponding to the accretion of notes payable, stock based compensation, depreciation and amortization of fixed assets, debt issuance costs, intangible amortization and amortization and accretion of discount and premium on investments;

 

   

Increase in accounts receivable of $2.0 million as a result of our increase in sales;

 

   

Decrease in inventories of $0.7 million;

 

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Increase of other current assets of $1.0 million primarily due to interest receivable from available-for-sale investments, lower deposit balances and higher prepaid balances due to timing;

 

   

Increase in accounts payable of $0.4 million primarily related to timing of payments; and

 

   

Decrease in other accrued and long term liabilities and accrued compensation of $2.0 million primarily for the 2010 incentive plans.

Investing Activities

Net cash used in investing activities for the nine months ended September 30, 2011 was $8.9 million, primarily due to investments purchases of $85.3 million and capital expenditures of $4.3 million primarily related to purchases of additional hysteroscopy and training equipment. These were offset by additional sales of short-term and long-term investments of an additional $80.5 million and a reduction in restricted cash of $0.2 million during the nine months ended September 30, 2011.

Net cash used in investing activities for the nine months ended September 30, 2010 was $25.3 million, primarily due to investments purchases of $89.8 million and capital expenditures of $4.1 million primarily related to purchases of additional hysteroscopy equipment. These were offset by the redemption of our Auction Rate Securities for $43.6 million at full par value and additional sales of short-term and long-term investments for additional $25.0 million during the nine months ended September 30, 2010.

Financing Activities

Net cash provided by financing activities for the nine months ended September 30, 2011 was $0.4 million primarily from the proceeds from stock options and awards exercises from our stock plans.

Net cash used in financing activities for the nine months ended September 30, 2010 was $26.9 million. This was due to the $35.8 million repayment of our UBS line of credit, offset by $2.3 million from the issuance of common stock from our stock programs and $6.6 million from borrowings under our UBS line of credit. In July 2010, we exercised our put option requiring UBS to purchase the underlying Auction Rate Securities at full par value and used the proceeds to repay the remaining balance of $14.2 million and terminated the line of credit.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying condensed consolidated financial statements and related footnotes. A description of our critical accounting estimates and policies is included in our Annual Report on Form 10-K for the year ended December 31, 2010. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. The primary estimates underlying our financial statements include reserves for obsolete and slow moving inventory, allowance for doubtful accounts receivable, product warranty, impairment for long-lived assets, income taxes, stock-based compensation and contingent liabilities. Other accounting policies are described in section “Critical Accounting Estimates and Policies” in our Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2010. Application of these policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04 – Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in Generally Accepted Accounting Principles (“GAAP”) and International Financing Reporting Standards (“IFRS”). ASU 2011-04 clarifies the application of existing fair value measurement requirements and results in common measurement and disclosure requirements in U.S. GAAP and IFRS. ASU 2011-04 also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is to be applied prospectively for reporting periods beginning on or after December 15, 2011. We anticipate that the adoption of this standard will not materially impact our Condensed Consolidated Financial Statements.

 

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In June 2011, the FASB issued ASU No. 2011-05 – Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in equity. ASU 2011-05 requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance is to be applied retrospectively for interim and annual periods beginning after December 15, 2011. On October 21, 2011, the FASB decided to propose a deferral of the new requirement to present reclassifications of other comprehensive income on the face of the income statement. Companies would still be required to adopt the other requirements contained in the new accounting standard for the presentation of comprehensive income. We anticipate that the adoption of this standard will not materially impact our Condensed Consolidated Financial Statements.

In September 2011, the FASB issued ASU No. 2011-08 – Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This ASU 2011-08 gives entities the option to perform the two-step process only if they first perform a qualitative assessment to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount and conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. This new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. We anticipate adopting this guidance in our fourth quarter of fiscal 2012 at the time we perform our annual goodwill test and do not expect that this standard will materially impact our Condensed Consolidated Financial Statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discusses our exposure to market risk related to changes in interest rates and foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results.

Interest Rate Risk: We maintain an investment portfolio of various holdings, types, and maturities. The values of our investments are subject to market price volatility. Our primary objective for holding investments is to achieve an appropriate investment return consistent with preserving principal and managing risk. As of September 30, 2011 we had short and long-term available-for-sale investments of $75.2 million recorded at fair value.

At any time, a sharp rise in interest rates could have a material adverse impact on the fair value of our investment portfolio, specifically investments in corporate bonds and U.S. government bonds. We had no outstanding hedging instruments for our investments as of September 30, 2011. We monitor our interest rate and credit risks, including our credit exposures to specific rating categories and to individual issuers. We monitor our investment portfolio to ensure it is compliant with our internal investments policy. We believe the overall credit quality of our portfolio is strong. There were no impairment charges on our investments for the three and nine months ended September 30, 2011. As of September 30, 2011, a hypothetical 100 basis point change in interest rates would not have a material impact on the fair value of our available-for-sale investments. See Note 3 – Investments in the Notes to Condensed Consolidated Financial Statements.

Foreign Currency Exchange Risk: A portion of our net sales are denominated in Euros and British Pounds. To date the foreign currency exchange risk related to British Pounds has been minimal due to the size of Conceptus Medical Limited.

We are exposed to foreign exchange rate fluctuations as we translate the financial statements of our foreign subsidiaries into U.S. Dollars in consolidation. If there is a change in foreign currency exchange rates, the translation of the foreign subsidiaries’ financial statements into U.S. Dollars will lead to translation gains or losses which are recorded net as a component of accumulated other comprehensive loss. We seek to manage our foreign exchange risk through operational means, including managing same currency revenues in relation to same currency expenses, and same currency assets in relation to same currency liabilities. Periodically, during 2011 we entered into forward contracts to buy U.S. Dollars at fixed intervals in the retail market in an over-the-counter environment. As of September 30, 2011, we had foreign currency forward contracts to sell 2.1 million Euros in exchange for $3.0 million maturing in October 2011 through December 2011. As of September 30, 2011 these forward contracts are recorded at their fair value of approximately $0.1 million as other current assets. We have outstanding short-term intercompany receivables of $3.5 million as of September 30, 2011. We expect the changes in the fair value of the intercompany receivables to be materially offset by the changes in the fair value of the forward contracts. A potential loss in fair value resulting from a hypothetical 10 percent strengthening in the value of the U.S. Dollar/local currency exchange rate would be approximately $0.4 million.

We have developed a foreign exchange policy to govern our forward contracts. The purpose of these forward contracts is to minimize the risk associated with foreign exchange rate fluctuations. These foreign currency contracts do not qualify as cash flow hedges and all changes in fair value are reported in earnings as part of other income and expenses. We have not entered into any other types of derivative financial instruments for trading or speculative purpose. Our foreign currency forward contract valuation inputs are based on quoted prices and quoted pricing intervals from public data and do not involve management judgment.

 

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures:

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of September 30, 2011, the end of our most recent fiscal quarter, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting:

There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations of Internal Controls

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

 

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On May 22, 2009, we filed a lawsuit in the United States District Court, Northern District of California against Hologic, Inc. seeking declaratory judgment by the Court that Hologic’s planned importation, use, sale or offer to sell of its forthcoming Adiana Permanent Contraception system will infringe several U.S. patents owned by us including U.S. Patent Nos. 6,634,361, 6,709,667, 7,237,552, 7,428,904 and 7,506,650, and an injunction prohibiting Hologic from importing, using, selling or offering to sell its Adiana system in the United States. Upon FDA approval of the Adiana Permanent Contraception system, we filed an Amended Complaint in July 2009 seeking a judgment that Hologic’s importation, use, sale and/or offer to sell the system infringes the same patents mentioned above and requested an injunction against such activity. On August 13, 2009, we filed a motion for preliminary injunction, requesting the Court to enjoin the Adiana system in the United States pending final judgment in the action. On August 25, 2009, Hologic filed its answer and asserted counterclaims against us that we were violating the Lanham Act and the California Statutory Unfair Competition Law. On October 14, 2009, we answered with our own counterclaims asserting that Hologic was violating the Lanham Act and the California Statutory Unfair Competition Law through its selling practices. A hearing was held on the motion for preliminary injunction on November 4, 2009 and an order denying the motion was issued on November 6, 2009. Upon stipulation of the parties, on January 19, 2010, all claims relating to three of the five asserted patents were dismissed with prejudice. A claim construction hearing was held on March 10, 2010. The Claim Construction Order was issued on March 24, 2010 with all but one of five terms favorably construed to us. On April 21, 2010 the Court issued an order granting our Motion to Amend our Complaint to assert counterclaims against Hologic that Hologic had engaged in unfair competition against us and had violated the Lanham Act. On August 10, 2010, the parties reached agreement to settle all the unfair competition claims of both parties with prejudice. The terms of the agreement are confidential. The parties filed cross –motions for summary judgment on October 28, 2010, which were heard on December 9, 2010. On December 16, 2010, the Court issued an order denying Hologic’s motions for summary judgment of non-infringement and invalidity of claims 37 and 38 of the asserted patent, granting Hologic’s motion for summary judgment of non-infringement as to claim 8, granting our motion for summary judgment as to non-infringing substitutes and the hypothetical negotiation date, and denying our motion for summary judgment of infringement. A jury trial on the two remaining patent claims was held from October 3 through 13, 2011. The jury verdict was in our favor on all counts. The jury found that Hologic indirectly infringed both patent claims and found that both patent claims were valid. The jury awarded us lost profits of $18.8 million based upon Hologic’s sales of Adiana through June 2011. A hearing our motions for a permanent injunction prohibiting Hologic from importing, using selling or offering to sell Adiana in the United States, for lost profits from June 2011 to the present, and for interest on lost profits is scheduled for December 22, 2011. On that same date, the Court will hear any motion for a new trial or for judgment as a matter of law to be filed by Hologic by November 15, 2011.

On August 10, 2010, Hologic filed a lawsuit in the United States District Court for the District of Massachusetts alleging that two of the twelve U.S. patents marked on our packaging, instructions for use, and marketing materials for our Essure® product do not cover the Essure product. On October 12, 2010, we made a Motion to Transfer to the United States District Court, Northern District of California and a Motion to Dismiss the action. On December 13, 2010, the Court denied the Motion to Transfer without prejudice to reconsideration upon submission of additional information about likely witnesses. The court heard our argument for our Motion to Dismiss on May 9, 2011 but has not yet ruled on the Motion. After the argument, we filed a Motion to Stay the litigation until the later of a ruling on the Motion to Dismiss and the trial in the infringement action described above. The Court granted that motion in orders entered July 5 and July 7, 2011, and the case is currently stayed.

From time to time, we are involved in legal proceedings arising in the ordinary course of business. We believe there is no litigation pending that could have, individually or in the aggregate, a material adverse effect on our financial position, result of operations or cash flows.

 

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Item 1A. Risk Factors

The risk factors included in our Annual Report as of December 31, 2010 on Form 10-K filed with the Securities and Exchange Commission on March 15, 2011 should be considered while evaluating Conceptus and our business. In addition to those factors and to other information in this Form 10-Q, the following updates to the risk factors as of September 30, 2011 should be considered carefully while evaluating the Company and our business.

We are a party to patent litigation, which is expensive and diverts our management’s attention.

On May 22, 2009, we filed a lawsuit in the United States District Court, Northern District of California against Hologic, Inc. seeking declaratory judgment by the Court that Hologic’s planned importation, use, sale or offer to sell of its forthcoming Adiana Permanent Contraception system will infringe several U.S. patents owned by us including U.S. Patent Nos. 6,634,361, 6,709,667, 7,237,552, 7,428,904 and 7,506,650, and an injunction prohibiting Hologic from importing, using, selling or offering to sell its Adiana system in the United States. Upon FDA approval of the Adiana Permanent Contraception system, we filed an Amended Complaint in July 2009 seeking a judgment that Hologic’s importation, use, sale and/or offer to sell the system infringes the same patents mentioned above and requested an injunction against such activity. On August 13, 2009, we filed a motion for preliminary injunction, requesting the Court to enjoin the Adiana system in the United States pending final judgment in the action. On August 25, 2009, Hologic filed its answer and asserted counterclaims against us that we were violating the Lanham Act and the California Statutory Unfair Competition Law. On October 14, 2009, we answered with our own counterclaims asserting that Hologic was violating the Lanham Act and the California Statutory Unfair Competition Law through its selling practices. A hearing was held on the motion for preliminary injunction on November 4, 2009 and an order denying the motion was issued on November 6, 2009. Upon stipulation of the parties, on January 19, 2010, all claims relating to three of the five asserted patents were dismissed with prejudice. A claim construction hearing was held on March 10, 2010. The Claim Construction Order was issued on March 24, 2010 with all but one of five terms favorably construed to us. On April 21, 2010 the Court issued an order granting our Motion to Amend our Complaint to assert counterclaims against Hologic that Hologic had engaged in unfair competition against us and had violated the Lanham Act. On August 10, 2010, the parties reached agreement to settle all the unfair competition claims of both parties with prejudice. The terms of the agreement are confidential. The parties filed cross –motions for summary judgment on October 28, 2010, which were heard on December 9, 2010. On December 16, 2010, the Court issued an order denying Hologic’s motions for summary judgment of non-infringement and invalidity of claims 37 and 38 of the asserted patent, granting Hologic’s motion for summary judgment of non-infringement as to claim 8, granting our motion for summary judgment as to non-infringing substitutes and the hypothetical negotiation date, and denying our motion for summary judgment of infringement. A jury trial on the two remaining patent claims was held from October 3 through 13, 2011. The jury verdict was in our favor on all counts. The jury found that Hologic indirectly infringed both patent claims and found that both patent claims were valid. The jury awarded us lost profits of $18.8 million based upon Hologic’s sales of Adiana through June 2011. A hearing on our motions for a permanent injunction prohibiting Hologic from importing, using selling or offering to sell Adiana in the United States, for lost profits from June 2011 to the present, and for interest on lost profits is scheduled for December 22, 2011. On that same date, the Court will hear any motion for a new trial or for judgment as a matter of law to be filed by Hologic by November 15, 2011.

On August 10, 2010, Hologic filed a lawsuit in the United States District Court for the District of Massachusetts alleging that two of the twelve U.S. patents marked on our packaging, instructions for use, and marketing materials for our Essure® product do not cover the Essure product. On October 12, 2010, we made a Motion to Transfer to the United States District Court, Northern District of California and a Motion to Dismiss the action. On December 13, 2010, the Court denied the Motion to Transfer without prejudice to reconsideration upon submission of additional information about likely witnesses. The court heard our argument for our Motion to Dismiss on May 9, 2011 but has not yet ruled on the Motion. After the argument, we filed a Motion to Stay the litigation until the later of a ruling on the Motion to Dismiss and the trial in the infringement action described above. The Court granted that motion in orders entered July 5 and July 7, 2011, and the case is currently stayed.

If we are unable to comply with the financial covenants in our credit facility, we will not be able to use the credit facility for future liquidity needs.

On August 25, 2011, we entered into a credit agreement (the “Agreement”) with a financial institution that provides for a revolving line of credit of up to $50.0 million to be used for working capital and general corporate purposes. As of September 30, 2011 we have no outstanding borrowings under the Agreement.

 

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Amounts available under the Agreement are available for immediate drawdown, subject to certain financial covenants and other restrictions. As of September 30, 2011 we were not in compliance with the pre-tax profitability covenant but the financial institution granted us a waiver with respect to this covenant for the third quarter of 2011. We cannot assure you will be able to comply or obtain a waiver, if necessary, from the financial institution with respect to the pre-tax profitability covenant or any other covenant in the future. If we were unable to do so, our ability to draw down under the Agreement in the future could be restricted, which could negatively impact our liquidity and require us to delay, reduce the scope of or eliminate our selling and marketing activities or other strategic business plans.

 

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Item 6. Exhibits

 

Number

  

Description

  10.1    First Amendment and Waiver to Credit Agreement dated August 25, 2011 by and between Conceptus, Inc. and Wells Fargo Bank, National Association. (incorporated by reference to Exhibit 10.1 to Company’s Current Report on Form 8-K filed with the SEC on August 26, 2011)
  10.2    First Amendment and Waiver to Credit Agreement, dated October 25, 2011, by and between Conceptus, Inc. and Wells Fargo Bank, National Association.
  31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101. INS    XBRL Instance Document
101. SCH    XBRL Taxonomy Extension Schema Document
101. CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101. LAB    XBRL Taxonomy Extension Labels Linkbase Document
101. PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

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Table of Contents

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 4, 2011

 

Conceptus, Inc.
/s/    GREGORY E. LICHTWARDT        
Gregory E. Lichtwardt
Executive Vice President, Treasurer and Chief Financial Officer

 

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